Earlier this year, the IRS issued two notices, 2021-20 and 2021-23, attempting to provide guidance on the Employee Retention Credit (“ERC”). The current notice (which can be found here) clarifies some of the earlier issued guidance and attempts to answer questions not previously addressed.
Full-time employees and full-time equivalents:
One question that arises frequently in determining ERC eligibility is whether full-time equivalents are included in the definition of a full-time employee in calculating the average number of employees. The answer in the Notice, and the conclusion that we originally reached, is that they are not. The Notice also confirms our position that “an employee’s status as a full-time employee is irrelevant and wages paid to an employee who is not full-time may be treated as qualified wages if all other requirements to treat the amounts as qualified wages are satisfied.”
Timing of the wage deduction disallowance:
It has always been clear that the ERC reduces an employer’s wage deduction. Moreover, the amount of qualified health expenses included in the ERC similarly affects deduction of such expenses. The unanswered question was: when is that reduction taken into account, especially when the ERC is claimed after the return for the year in question is filed?
While some commentators suggested that a catch-up adjustment was appropriate, our position has been that unless the return for the year in question could be affected before filing, the taxpayer must file an amended return (or, in the case of a partnership, an Administrative Adjustment Request or “AAR”) for the taxable year in which the qualified wages were paid or incurred.
Shareholder/employee wages and related individuals:
A controversial question was whether wages paid to a 50% or more owner of a corporation or their spouse are qualified wages for purposes of the ERC. The enabling legislation provides that rules similar to those used for the Work Opportunity Credit (“WOC”) were to be applied in making this determination. Those rules state that wages paid to certain relatives of 50% or more owners of the business are not qualified including:
- A child or a descendant of a child
- A brother, sister, stepbrother, or stepsister
- The father or mother, or an ancestor of either
- A stepfather or stepmother
- A niece or nephew
- An aunt or uncle
- A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
- An individual (other than a spouse) who lives with the taxpayer and is a member of the taxpayer’s household
The relevant Internal Revenue Code section goes on to state in a parenthetical reference that certain constructive ownership rules are to be applied in determining who is considered a 50% or more owner.
Generally, for purposes of the WOC, wages paid to the owner of the business wouldn’t be eligible for the credit because they aren’t likely to be in one of the targeted groups that has “consistently faced barriers to employment.” As a result, there isn’t much published guidance on the treatment of majority owners or their spouses.
In the Notice, the IRS and Treasury Department have decided to quite broadly (and we think perhaps inappropriately) interpret the parenthetical language with regard to constructive ownership. So, since an owner’s shares can be deemed owned by their brother or sister or child or parent, any majority owner with such a relationship would be deemed to be related to an indirect owner of a majority interest. As a result, their wages would not be qualified wages for the ERC. Similarly, the wife of a majority shareholder would also have their wages disqualified by working through the attribution and relationship rules.
Hopefully, future guidance will liberalize this interpretation. In the meantime, we suggest claiming the ERC for all other qualified wages but waiting to claim it with respect to majority shareholder and shareholder spouse wages. Unless of course those persons have no immediate other relatives.
The major new topics of Notice 2021-49 deal with the following:
- Impact of the extension of the ERC to the third and fourth quarters of 2021
- Certain definitions related to a new class of eligible employer, the “Recovery Startup Business”
- Definition of qualified wages paid by a “severely financially distressed employer”
- Rules for coordination with the Shuttered Venues Operator and Restaurant Revitalization Grant programs
As these are very specific, please reach out to a member of the Friedman LLP ERC Team to discuss how they may apply to your business.